Political connections in turbulent times

By Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak, Todd Mitton

This post was originally published at Vox.

Political connections affect economic outcomes in emerging markets. This column discusses new evidence showing that something similar goes on in the US. Over the ten trading days following the announcement of Timothy Geithner as Treasury Secretary, financial firms with a connection to Geithner experienced a cumulative abnormal return of about 12% relative to other financial sector firms. This reversed when his nomination ran into trouble due to unexpected tax issues.

When assessing the political situation in many countries, it is common practice, and entirely reasonable, to consider who has what kind of personal connection to people in, or contending for, power.

  • Alliances in the ongoing struggle in Ukraine are partly determined by who has deep connections to President Viktor Yanukovych and his family (Shynkarenko 2014, Motyl 2012).
  • Assessing oil revenue management in Equatorial Guinea or the potential for full-blown civil war in South Sudan – both in the news recently – requires thinking about who has long been aligned with leading public figures, including family, friends, and established allies (Blum 2004, Ajak 2014).
  • The latest accusations of illegal behaviour by international banks are focused on whether UBS and JP Morgan Chase hired the children of prominent Chinese officials, specifically in order to make the kind of connection that can curry favour, or win business (Davies and Hall 2014).

In a seminal 2001 paper, Ray Fisman mapped out the connections of various Indonesian companies to then-President Suharto, and showed that the market value of these companies varied – relative to the value of otherwise similar companies – as rumours spread about Suharto’s health. When Mr Suharto’s life was considered to be in danger from a heart condition, there was a fall in the value of companies run by people with whom he had a long-standing relationship – presumably because these firms stood to lose a degree of access to power that was considered valuable. This kind of approach has become a powerful tool for understanding political realities, as well as the relationships between private firms and public officials. It also guides thinking about some macroeconomic situations, including financial crises.

For example, in his 2000 lecture to the American Economic Association, then-Treasury Secretary Larry Summers argued one element in “the loss of confidence in the financial system and episodes of bank panics” was political distortions and interferences in the way interventions [in insolvent financial institutions] were carried out (as when an Indonesian bank owned by a son of President Soeharto [sic] was closed one day to be reopened the next, under a different name in the same premises).

Connections matter in the US as well

Until recently, however, there was a general presumption in US policy circles that such connections mattered more in countries with weak rule of law, and not so much in richer parts of the world – like the US. And the pejorative term ‘crony capitalism’ was often used to describe the relationship between business people and politicians in countries without effective constraints on what elites can get away with.

Now a new wave of research brings into clearer focus instances when connections matter a great deal even in the US. Should we think of such connections as completely normal in all political systems? Or do they indicate that some deleterious form of crony capitalism has taken root in the US, as suggested by the Occupy Wall Street movement and others?

Most of the evidence so far has been about Congress. For example, in a recent paper Pat Akey (2013) looks at the abnormal returns in stock prices around close US congressional elections. Firms gain upon the election of a politician with whom they are connected – and they lose when such an individual is defeated. The amounts of money can be significant; Akey estimates the cumulative abnormal return to be between 1.7% and 6%. Investors believe these kinds of connections are valuable.

More broadly, access to government officials can be hugely beneficial – and seems to be what the large US lobbying industry is about, as opposed to simply sharing information or anything else that improves decision-making. When powerful congressional representatives are involved in policy, they may be influenced by the people they talk to – and the people with whom they talk will likely be the people they know. Marianne Bertrand, Matilde Bombardini, and Francesco Trebbi (2011) find that lobbyists switch issues when their congressional friends change committee assignments, suggesting that knowing people is more important than understanding issues. Similarly, Jordi Blanes-i-Vidal, Mirko Draca, and Christian Fons-Rosen (2012) find a big loss of income for lobbyists when a senator with whom they are connected leaves Congress.

New evidence

In “The value of political connections in turbulent times: evidence from the US”, we explore the power of connections with the executive branch of the US government. Specifically, we focus on the quasi-natural experiment in November 2008 when Timothy Geithner was picked as Treasury Secretary by President-elect Barack Obama.

Geithner had an important set of social connections, mostly from his time as president of the Federal Reserve Bank of New York. He knew some people in finance very well – including those at both large and small firms. But he was also completely unconnected – in this social sense – to many financial-sector firms.

  • Over the ten trading days following the announcement, financial firms with a connection to Geithner experienced a cumulative abnormal return of about 12% relative to other financial sector firms – the kind of reaction that might typically be expected in an Indonesia-type situation.
  • When Geithner’s nomination ran into trouble in January 2009, due to unexpected tax issues, there was a fall in the value of Geithner-connected firms – although this effect is smaller and less precisely estimated than the increases that were observed in November.

There are plausible alternative hypotheses, including the possibility that Mr Geithner was just seen as a safe pair of hands who would help turn around the economy (although this does not explain why Geithner-connected firms would do better than otherwise similar unconnected firms). But when we control for firms’ sensitivity to a potential worsening of the crisis – for example using how their stock price moved immediately after Lehman Brothers collapsed in September 2008 – our results remain robust.

Similarly, while Mr Geithner may have been expected to favour a few very big firms that he knew well – like Citigroup – size of assets, or any measure of a firm being ‘too big to fail’, is not what drives our results. When we drop Citigroup and financial firms highly correlated with Citi, which includes the biggest banks, our results remain very strong. The same is true when we drop all firms that might reasonably be considered to have systemic importance.

Interestingly, when we look at other executive branch appointments – including when Henry (Hank) Paulson became Treasury Secretary in May 2006 – there is no evidence of a positive impact on the stock price of connected firms (this was just Goldman Sachs in Mr Paulson’s case). There seems to have been something different about the crisis environment of November 2008 – and this is presumably the heightened degree of discretion, as well as the large amount of resources to be deployed, in the hands of the Treasury Secretary.

The response of stock prices suggests what we call a ‘social connections meet the crisis’ interpretation. Connections to the US executive branch matter more during a time of crisis and increased policy discretion. It was entirely reasonable for market participants to suppose that immediate action with limited oversight would have to be taken, and that officials would rely on a small network of established confidantes for advice and assistance. In fact, this is exactly what happened while Mr Geithner was at Treasury.

To be clear, our event study does not suggest that anything inappropriate or illegal took place. Powerful government officials are no different from the rest of us – they know and trust a limited number of people. It is therefore natural to tap private sector friends, associates, and acquaintances with relevant expertise when needed – including asking them for advice and hiring them into government positions.

Concluding remarks

Even with the best intentions, beliefs are presumably shaped by self-interest, particularly when the people involved were, are, or will be executives with fiduciary responsibility to shareholders – and an eye on their own potential to earn bonuses. Any such tendencies within the US executive branch can more easily be checked during ordinary times by institutional constraints and oversight, including by Congress and through the media, but during times of crisis and urgency, social connections are likely to have more impact on policy.

At the very least, these results suggest that the US is not as different from other countries as we sometimes like to think. However, further study is needed to assess exactly which firms received what kind of advantage while Mr Geithner was at Treasury. Hopefully, such studies will allow us to compare not just market reactions, but also the detailed realities of bailout and other government support policies across countries.


Acemoglu, D, S Johnson, A Kermani, J Kwak, and T Mitton, (2013), “The value of political connections in turbulent times: evidence from the US”, National Bureau of Economic Research working paper 19701, December.

Ajak, Peter B (2014), “South Sudan’s unfinished business”, The New York Times, opinion pages, 6 February.

Akey, P (2013), “Valuing changes in political networks: evidence from campaign contributions to close congressional elections”, Unpublished working paper, January.

Bertrand, M, M Bombardini, and F Trebbi, (2011), “Is it whom you know or what you know? An empirical assessment of the lobbying process”, NBER Working Paper 16765.

Blanes-i-Vidal, J, M Draca, C Fons-Rosen, (2012), “Revolving door lobbyists”, The American Economic Review 102(7), 3731-48.

Blum, J (2004), “U.S. oil firms entwined in Equatorial Guinea deals”, The Washington Post, 7 September.

Davies, P and C Hall (2014), “UBS suspends two bankers over hiring investigation”, Financial Times, 10 February.

Fisman, R (2001), “Estimating the value of political connections”, American Economic Review 91(4), 1095-1102.

Motyl, A J (2012), “Ukraine: The Yanukovych family business”, The World Affaird, 23 March.

Shykarenko, O (2014), “Yanukovych’s friends on the Hill”, The Daily Beast, 10 February.

Summers, L (2000), “International financial crises: causes, prevention, and cures”, The American Economic Review 90(2), 1-16, Richard T. Ely Lecture.


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